In some economic situations, one person can gain by taking risk, but another person or business pays for losses {moral hazard}. First person loses little if enterprise fails. Second entity can gain little if enterprise succeeds. Statistically, houses with fire insurance for original house value are more likely to have fires if house value goes down. Statistically, unregulated financial institutions with government insurance for investor money are more likely to issue risky financial instruments.
To prevent moral hazard, second entity must require first person to risk his or her money. For houses, house down payment must be large enough to deter owner from risking loss. For financial institutions, leverage must not be too great, and managers must adhere to principles. Second entity must require that loaned money go only to stated purpose, not to risky investments.
Social Sciences>Economics>Psychology
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Date Modified: 2022.0224